The Hidden Value Of McClatchy Newspapers

By Will Ashworth | October 11, 2011 AAA

U.S. newspaper advertising revenue declined 6.9% in the second quarter to $6 billion. This is the 20th consecutive decline; you have to go all the way back to the second quarter of 2006 for an increase. Needless to say, most newspaper publishers in this country saw print advertising revenues decline between April and June 2011, no more so than The McClatchy Company (NYSE:MNI), publishers of the Miami Herald and Sacramento Bee among others, which saw an 11.8% drop in Q2.

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It doesn't look good for the 150-year-old publisher. However, with its share price well under $2, here are several reasons why now is the perfect time to take a flyer on its stock. (For help on advertising for your business, see Advertising, Crocodiles And Moats.)

Balance Sheet/Debt Situation
Let's make our way from the bad news to the good news. Whenever you get an extended period of declining revenues, this is where the problems really present themselves. The McClatchy Company ended the second quarter with $1.6 billion in long-term debt, half of which is at 11.5% - an unfathomable amount given this low interest-rate environment. Last year it paid $178 million in interest and this year it'll likely be around $20 million less, but still a completely debilitating amount.

Ironically, both Moody's and Standard & Poor's upgraded McClatchy's credit rating in February 2010 upon the news of its $875 million bond sale. Although the interest rate was higher, the rating agencies felt the stability of the bond deal along with the fact that it pushed back the repayment date for half its debt, presented the company with an opportunity to improve its future situation while still being able to meet its obligations.

Anyone who has been in debt knows what it's like to have the clock ticking without a solution. The bond deal removed the short-term burden and as of today, the company still has five years to dig itself out of this mess. It is possible, but McClatchy does need a little more cooperation from the general economy and right now, that's not happening. At the end of the day, it's important to note that with the exception of 2007 when it took an impairment charge of $3 billion, the last five years have all resulted in operating profits, not losses, and that's meaningful.

Pension
The average funding ratio for the pensions of all 50 states is 79.1%. This means that the average state underfunds its employee pension plan by 21%. In the case of The McClatchey Company, it ended 2010 with a defined benefit plan that was only 64% funded. In the second quarter, fresh off selling 14 acres of land at its Miami operation for $236 million, the company wisely ploughed $163 million of the proceeds into its pension plan, bringing the funding ratio up to 81.4%, now higher than the state average.

More importantly, the contribution was tax deductible, reducing the taxes payable on the sale of land while simultaneously lowering the pension contribution it will have to make in 2012 by $45 million. The tax savings plus the $45 million that would have gone to the pension plan can now go to debt repayment, which will further strengthen the company. Thus, its existing employees get a double-dose of good news heading into the second half of the year. (For more on pension plans, check out Pension Plans: Pain Or Pleasure?)

Internet Investments
The big winner in the first half of the year was its equity investments, which generated net income of $12.7 million, up from $2.8 million in the first half of 2010, a loss of $700,000 in the first half of 2009 and a loss of $13.5 million in the first half of 2008. In three short years, its 14.4% interest in CareerBuilder, 25.6% of Classified Ventures, 33.3% of HomeFinder, 27.0% of Ponderay Newsprint Company and 49.5% of the Seattle Times Company has really helped bolster the bottom line. As of the end of 2010, these investments were valued at $307 million.

No more important to the company was its 25.6% interest in Classified Ventures LLC, an online classified advertising business that it owns in partnership with A.H. Belo (NYSE:AHC), Gannett (NYSE:GCI), The Washington Post Company (NYSE:WPO) and the Tribune Company. In the fourth quarter of 2010, McClatchy received a first-ever dividend of $24.3 million from the venture, which it used to pay down debt.

The Bottom Line
The McClatchy Company has a lot of work to do improving both its income statement and balance sheet. However, it still generates strong free cash flow and trades for less than book value. I wouldn't bet the farm, but it certainly has far more upside than downside at this point. (To see if this stock is a good fit for your portfolio, see How To Pick A Stock.)

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